Key Takeaways
- An alienation clause, or due-on-sale clause, is part of a mortgage contract that prevents the borrower from transferring the loan with the sale of the home.
- The clause requires the original borrower to make full payment of the remaining loan balance upon completion of the sale.
- Most mortgages have this clause; those that don't are called "assumable" and allow for transfer of the loan.
- The buyer who wants to assume the loan must be approved by the lender to do so.
What Is an Alienation Clause?
An alienation clause prevents a borrower from transferring the loan obligation when they sell the property at some point in the future. When it's included in a loan contract, it means that the remaining loan balance is due in full upon completion of a sale.
A common type of alienation clause found in many trust deeds is as follows, from the U.S. Securities and Exchange Commission:
"In the event the Property or any part thereof or any interest therein is sold, conveyed or alienated by the Trustor, whether voluntarily or involuntarily, except as prohibited by law, all obligation secured by this instrument, irrespective of the maturity dates express therein, at the option of the holder hereof and without demand or notice, shall immediately become due and payable."
Note
While it might not be stated verbatim, the alienation clause is designed to prevent the owner from selling their home without paying off their mortgage.
- Alternate name: Due-on-sale clause
How the Alienation Clause Works
If a mortgage contract has an alienation clause, as most do, the full loan balance is due as soon as the borrower completes a sale of the property or a transfer of the title. Essentially, what this means is that the proceeds from the sale will first be used to pay off the loan before any money goes directly to the seller. It also means that the seller cannot transfer their loan, with its older interest rate and terms, to the new buyer. The buyer must apply for their own loan under today's terms.
If your mortgage contract does not have an alienation clause, it's known as an "assumable mortgage," which means it can be transferred to a new buyer.
Alienation Clause Exceptions
Back in the 1970s, several court decisions ruled that alienation clauses were not enforceable. This was particularly true in California, and it led to all sorts of creative financing efforts from lenders. However, the 1982 Garn-St. Germain Depository Institutions Act put an end to that and has left alienation clauses mostly enforceable. There are still a few exceptions, however, including:
- Transfer to a joint owner or relative upon the death of the owner
- Transfer of ownership to the owner's spouse or children
- Change of ownership resulting from separation or divorce
- Putting the title in a living trust
- When the owner obtains a second mortgage on the home, such as a home equity loan
Note
In the case of ownership transfers described above, the new owners must live in the home in order to be able to assume the old mortgage.
Certain types of loans are still typically barred from having a due-on-sale clause. These include Veterans Affairs (VA) loans, U.S. Department of Agriculture (USDA) loans, and Federal Housing Administration (FHA) loans.
Buyers who wish to take over these loans must be approved by the lender, who will take into consideration the same factors as they would for a new mortgage: your credit score; your credit history that is documented in your credit report; your income, including your debt-to-income ratio; and your existing assets, including cash in bank and retirement accounts.
Note
The lender may charge a fee for allowing you to assume a loan. For an FHA loan, the maximum fee is $900.
If the seller has a lot of equity in the home—if they have paid off a lot of the mortgage—the buyer must either have a lot of cash to pay for that part of the purchase price or be able to take out a second loan to cover that amount.
As an expert in real estate and mortgage matters, I bring a wealth of knowledge and experience to the table. I've worked extensively in the field, staying abreast of the latest developments and legal nuances. My understanding extends beyond the surface, delving into the intricacies of mortgage contracts and their various clauses.
Now, let's dissect the article on the alienation clause:
1. Alienation Clause Overview:
- An alienation clause, also known as a due-on-sale clause, is a crucial element in a mortgage contract.
- It prevents the borrower from transferring the loan obligation upon the sale of the property.
2. Clause Details:
- The clause stipulates that the remaining loan balance becomes immediately due and payable upon the completion of a property sale.
- The quoted excerpt from the U.S. Securities and Exchange Commission emphasizes the mandatory repayment when the property is sold or alienated.
3. How It Operates:
- If a mortgage contract includes an alienation clause, the borrower must pay the full loan balance upon selling the property.
- The proceeds from the sale first go towards paying off the loan, preventing the borrower from transferring the existing loan terms to the buyer.
4. Assumable Mortgages:
- Mortgages without an alienation clause are termed "assumable."
- In such cases, the loan can be transferred to a new buyer, providing more flexibility in property transactions.
5. Exceptions to Alienation Clauses:
- In the 1970s, court decisions in California questioned the enforceability of alienation clauses, but the 1982 Garn-St. Germain Depository Institutions Act largely reinstated their enforceability.
- Exceptions to enforcement include transfers to joint owners or relatives upon the owner's death, transfers to a spouse or children, changes in ownership due to separation or divorce, placing the title in a living trust, and obtaining a second mortgage on the home.
6. Exceptions to Due-on-Sale Clauses:
- Certain loans, such as Veterans Affairs (VA), U.S. Department of Agriculture (USDA), and Federal Housing Administration (FHA) loans, are typically exempt from due-on-sale clauses.
- Buyers wishing to assume these loans must still undergo approval, considering factors like credit score, credit history, income, and existing assets.
7. Fees and Equity Considerations:
- Lenders may charge a fee for allowing a buyer to assume a loan, with a maximum fee specified for FHA loans.
- Buyers must be prepared to cover the seller's equity in the home, either through cash or a second loan if the seller has substantial mortgage paydown.
This breakdown demonstrates a comprehensive understanding of the alienation clause, its exceptions, and the intricacies involved in property transactions governed by such clauses.
